Paycheck Protection Program Loans: Forgiveness

May 28, 2020

Recently, the U.S. Small Business Administration (SBA) released its overdue Paycheck Protection Program (PPP) Loan Forgiveness Application and an Interim Final Rule (IFR) regarding loan forgiveness under Section 1106 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). This client alert summarizes key aspects of this guidance.

I. Costs Incurred and Paid

PPP loan proceeds (plus accrued interest on the loan itself) are generally forgivable under Section 1106(b) of the CARES Act so long as they are used to pay the following “costs incurred and payments made” during the Covered Period (eight weeks following the disbursement of a PPP loan): 1) payroll costs, 2) utilities, 3) rent and 4) mortgage interest. Eligible payroll costs include salary, wages and tips, up to $100,000 prorated for the Covered Period per employee (or $15,385 maximum per individual), plus payment for vacation, parental, family, medical or sick leave, plus any allowances paid to employees for separation or dismissal, plus payments for employee benefits consisting of group health care coverage (including insurance premiums) and retirement contributions, plus payment of state and local taxes assessed on the compensation of employees. As established by prior rule, such payroll expenditures must account for at least 75% of the loan forgiveness amount.

Previously, there had been some confusion as to whether the payroll costs must be paid and incurred during the Covered Period, or whether the payroll costs could be incurred but not paid. Both the Application and the IFR provide much needed clarity on this topic and generally provide an expansive interpretation of the CARES Act. Both the Application and the IFR state that “payroll costs paid or incurred” during the Covered Period are generally eligible for forgiveness, but also specify that payroll costs must be paid during the Covered Period in order to be eligible for forgiveness unless the payroll cost is incurred during the last pay period, in which case it must be paid on the next regular payroll date

Similarly, non-payroll costs (i.e. utilities, rent and mortgage interest payments) must be paid during the Covered Period or incurred during the Covered Period and paid before the next regular billing date. Such non-payroll expenditures cannot exceed 25% of the loan forgiveness amount. Moreover, to be eligible for forgiveness, mortgage obligations, rent or lease agreements, and utility service arrangements would have had to have been in place before February 15, 2020.

II. Bonuses and Retirement Plan Contributions

There was also some confusion as to whether compensation in the form of bonuses or hazard pay would be eligible for forgiveness since the CARES Act uses the phrase “compensation in the form of salary, wages, commissions or similar compensation.” The IFR, however, provides an expansive interpretation of this phrase to include bonuses and hazard pay as long as total compensation does not exceed $100,000 on an annualized basis.

We were also waiting for additional guidance as to how much of a retirement plan contribution (such as to an employee stock ownership plan (ESOP), profit sharing plan or defined benefit pension plan) would be eligible for forgiveness or whether only a prorated portion of such a contribution would be eligible for forgiveness. Neither the Application nor the IFR provides explicit guidance on this topic, but by permitting forgiveness for payroll costs paid during the Covered Period or incurred during the last pay period and paid on the next regular payroll date, it appears that a contribution to a retirement plan is eligible for full forgiveness regardless of whether it relates to a 2019 or 2020 plan year, and there is no requirement that such contributions must be prorated for the Covered Period. Further, the $100,000 cap on annualized compensation does not apply to employee benefits for non-employee owners.

Notwithstanding this expansive interpretation of the forgiveness rules for retirement plan contributions, we encourage employers to carefully consider the impact that non-forgiveness would have on cash flow if the SBA were to issue further guidance that changes this interpretation similar to the process the SBA has undertaken with previous guidance.

III. Alternative Payroll Covered Period

The Application permits borrowers to select an “alternative payroll covered period” for purposes of determining the payroll costs in the event that a borrower has a bi-weekly or more frequent payroll cycle. The alternative payroll covered period (Alternative Covered Period), if elected, is the eight-week (56 day) period beginning on the first day of the first pay period following the PPP loan disbursement date.

IV. Caps on Owner-Employee Compensation

The IFR places a new limit on loan forgiveness available to owner-employees and self-employed individuals. An owner-employee and self-employed individual cannot seek forgiveness for payroll compensation in an amount more than the lesser of (i) 8/52 of the individual’s 2019 compensation or (ii) $15,385. In connection with compensation paid in 2019, this cap applies to both employee cash compensation and employer retirement and health care contributions made on behalf of the employee. The IFR also states that this limit applies “in total across all businesses.” In other words, if an individual owns more than one business, the cap is an aggregate covering all businesses owned by such owner-employee.

Note: Additional clarification is still needed about what is meant by “owner-employees.” The IFR does not define the term “owner-employee”. Although an employee that owns 100% of the equity of a borrower would likely be considered to be an “owner-employee,” it is not clear whether an employee who owns only a portion of the equity of a borrower would be considered an “owner-employee.

V. Loan Forgiveness Reductions

Borrowers must apply two tests to determine whether they must reduce the amount of forgiveness they may include in the forgiveness Application, one based on headcount of full-time equivalents (FTEs) and one based on payroll. Two calculation methods may be used for determining FTEs. In the first method—the Traditional Method—the average FTE is determined by taking the average number of hours paid each week for each employee, dividing that by 40, and rounding the total to the nearest tenth. In the second method—the Simple Method—the borrower assigns 1.0 FTE for each employee who works 40 hours or more per week and 0.5 FTE for each employee who works fewer than 40 hours.

If a borrower has reduced FTEs during the Covered Period or the Alternative Covered Period compared to FTEs on the payroll during the borrower’s chosen base reference period (Feb. 15, 2019 through June 30, 2019 or Jan. 1, 2020 through Feb. 29, 2020), it must reduce the forgiveness amount applied for proportionately. For example, a 30% reduction in FTEs over these periods would require a 30% reduction in the total forgivable amount.

When calculating FTEs for the Covered Period or the Alternative Covered Period, as applicable, the SBA provided employer-favorable guidance that permits the borrower to exclude any reduction in FTEs attributable to individual employees if the borrower made a good faith written offer to rehire such employees for the same salary or wages and the same number of hours earned during the last pay period prior to separation and the offer was rejected by the employees. To take advantage of this special rule, the borrower must maintain records documenting the offer and rejection and must inform the state unemployment insurance office of the rejection within 30 days of the rejection. Further information regarding how borrowers will report information concerning rejected rehire offers to state unemployment insurance offices will be provided on the SBA’s website. Also, if employees are fired for cause, voluntarily resign or voluntarily request a reduced schedule during the Covered Period or the Alternative Covered Period, as applicable, the borrower may count such employees as the same FTE equivalent the employee had counted prior to the reduction.

The forgiveness amount will be reduced if the reduction in wages/salary during the Covered Period or the Alternative Covered Period, as applicable, is in excess of 25% of the total wages or salary of an employee from January 1, 2020 through March 31, 2020. This test is on a per-employee (not an aggregate) basis. Employees with annualized wages or salary of more than $100,000 in any pay period during 2019 are not included in this calculation. A literal reading of the IFR seems to indicate that if there was one pay period in 2019 that when annualized causes the employee to exceed the $100,000 threshold, the 25% reduction would not be applicable to this employee even if it was a one-off payroll event, such as a large bonus during one payroll period. As with retirement contributions, we encourage borrowers to be wary: the SBA may change this interpretation in future guidance.

Another open question from the CARES Act was how the FTE reduction and the salary/wage reduction would interact with each other, if at all. The IFR provides that the salary/wage reduction applies only to the portion of the decline in salary and wages that is not attributable to the FTE reduction. For example, if an employee’s hourly wages remain the same but there is a reduction in the number of hours worked, that would only cause a reduction in forgiveness related to the FTE decline but would not require a reduction in forgiveness related to salary/wages even though the employee would have reduced compensation because of the hours decrease.

Finally, the IFR interprets the restoration provision of the CARES Act in a manner favorable for borrowers. If there was a reduction in salary/wages during the time between February 15, 2020 and April 26, 2020 (the Safe Harbor Period), but those reductions are eliminated by June 30, 2020, or earlier, the borrower is not subject to the salary/wages reduction regardless of the actual salary/wage reductions during the Covered Period. A similar rule applies for restoration of FTEs by June 30, 2020, related to reductions to FTEs during the Safe Harbor Period.

VI. Concluding Thoughts

The Application and the IFR interpret and apply the CARES Act in a very favorable way for borrowers, particularly with respect to bonuses, retirement plan contributions and forgiveness. Each additional release of SBA guidance, however, provides additional clarity for this new and hastily implemented program. As noted above, there remain open questions, and employers will likely need to take uncertain positions in applying for loan forgiveness. Additional guidance could be issued by the SBA and as of this writing, it appears quite possible that further legislative action may extend the forgiveness period and/or reduce the threshold for proceeds required to be used on payroll costs. Our firm continues to monitor the additional guidance and further legislation on a daily basis. We will issue updates to this client alert as our team becomes aware of any new information.

Please contact Jim Steiker, Ed Renenger or the SES ESOP Strategies’ professional with whom you regularly work if you have questions or need assistance with this process.

Related Professionals:
James G. Steiker
Edward C. Renenger

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.